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Bond Funds and Fixed-Income Market Liquidity: A Stress-Testing Approach

Author

Listed:
  • Rohan Arora
  • Guillaume Bédard-Pagé
  • Guillaume Ouellet Leblanc
  • Ryan Shotlander

Abstract

This report provides a detailed technical description of a stress test model for investment funds called Ceto. The model quantifies how asset sales from investment funds could amplify a sudden decline in asset prices through the liquidity risk premium of the corporate bond market. Ceto is grounded in the literature on agents’ incentives and behaviour: it considers the response of investors to fund performance and the liquidity-management decisions of portfolio managers to meet demands for redemptions. The model also explicitly accounts for the provision of liquidity by broker-dealers and other potential buy-side investors. By accounting for the behaviour of different types of market participants, our approach allows us to account for the rich institutional features of, and heterogeneity within, the Canadian corporate bond market. The model can accommodate a range of different risk scenarios.

Suggested Citation

  • Rohan Arora & Guillaume Bédard-Pagé & Guillaume Ouellet Leblanc & Ryan Shotlander, 2019. "Bond Funds and Fixed-Income Market Liquidity: A Stress-Testing Approach," Technical Reports 115, Bank of Canada.
    • Handle: RePEc:bca:bocatr:115
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    References listed on IDEAS

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    Cited by:

    1. Rohan Arora & Guillaume Bédard-Pagé & Guillaume Ouellet Leblanc & Ryan Shotlander, 2019. "Could Canadian Bond Funds Add Stress to the Financial System?," Staff Analytical Notes 2019-9, Bank of Canada.
    2. Rohan Arora & Guillaume Bédard-Pagé & Guillaume Ouellet Leblanc & Ryan Shotlander, 2019. "Les fonds d’obligations canadiennes peuvent-ils amplifier les tensions subies par le système financier?," Staff Analytical Notes 2019-9fr, Bank of Canada.
    3. Charles Gaa & Xuezhi Liu & Cameron MacDonald & Xiangjin Shen, 2019. "Évaluer la résilience du système bancaire canadien," Staff Analytical Notes 2019-16fr, Bank of Canada.
    4. Thierry Roncalli & Fatma Karray-Meziou & Franc{c}ois Pan & Margaux Regnault, 2021. "Liquidity Stress Testing in Asset Management -- Part 1. Modeling the Liability Liquidity Risk," Papers 2101.02110, arXiv.org.
    5. Charles Gaa & Xuezhi Liu & Cameron MacDonald & Xiangjin Shen, 2019. "Assessing the Resilience of the Canadian Banking System," Staff Analytical Notes 2019-16, Bank of Canada.

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    More about this item

    Keywords

    Economic models; Financial Institutions; Financial markets; Financial stability;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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